Regulators move in on digital tokens after investor scams

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Peter Sussman was running on three hours sleep when he lost $20,000 to a fraudster working on the edges of the "initial coin offering" market - a new way companies are raising money by selling investors digital tokens in exchange for virtual currency such as bitcoin.

The 27-year-old software developer from Illinois had been awake all night researching the ICO for a yet-to-be-launched product called TokenCard, which offered buyers of limited "TKN" tokens the opportunity to support "the first debit card powered by smart contracts".

Worried he would miss out on the sale as he waited for the ICO website to load, Mr Sussman was fooled by a scammer posing as a TokenCard representative in an online messaging forum. Thirty seconds later, he realised he had sent his funds to the wrong address and lost the equivalent of almost half his annual salary.

Scams like this have become common as retail investors have piled into the growing ICO market. At the same time, regulators have started to take note: China announced on Monday it was banning them, and called a halt to fundraising involving virtual coins.

TokenCard was one of 60 ICOs in the second quarter of 2017, according to research company Smith + Crown. In that time, ICOs raised the equivalent of $863,173,000 - nearly five times more than had been raised since they were invented in 2013. Though these valuations are based on the value of the virtual currency that companies acquire in the process.

The largest ICO this year was Tezos, which in July raised $232m of the digital currencies bitcoin and Ether. The aim was to fund the development of a new kind of "blockchain" - a shared database of transactions best known for its use in bitcoin.

Although ICOs have been around for several years, Marshall Swatt, co-founder of digital currency exchange Coinsetter, said the huge increase in the value of digital currencies had brought new interest from "investors, traders, the media, and average individuals", including people who want to invest their now valuable digital assets in other virtual projects. In 2013, bitcoin were being traded for about $135, nowadays they are moving towards $5,000.

But some established members of the industry say they are alarmed by the ICO boom and want tougher regulation.

"There are people in the ICO market right now who will end up in orange jumpsuits," said Brad Garlinghouse, chief executive of Ripple, a company that provides interbank payment software using blockchain and runs its own virtual currency, XRP.

In July, the US Securities Exchange Commission reminded market participants that securities laws apply to the sale of digital assets and in late August, it warned investors about ICOs, saying: "Fraudsters often try to use the lure of new and emerging technologies to convince potential victims to invest their money in scams."

Nonetheless, at the moment, companies can launch an ICO with just a simple document that explains their offer and the privileges granted to token buyers vary widely, from access to software under development, to owning "land" in a virtual world.

Michael Gronager, chief executive of blockchain research company Chainanalysis, compares the chance a buyer takes on ICO tokens to theatre tickets.

"If it's Hamilton, you probably made a good investment," he said, referring to the blockbuster US musical that inspired frenzied ticket trading. "But if it's not, you didn't."

Marco Santori, a US lawyer specialising in cryptocurrency, said he expects further regulatory action, and that the SEC warnings were "a shot across the bow of the industry".

Authorities in Canada and Singapore confirmed last month that some ICOs could be classified and regulated as securities. In Israel, which has a large financial technology industry, the securities regulator announced on August 30 that it would be looking into ICOs and could change the rules depending on its findings.

China's National Internet Finance Association last week said that ICOs were disrupting the economic and social order.

Pawel Kuskowski, chief executive of regulatory technology company Coinfirm, argues existing regulation should be sufficient. "The problem is that lots of the projects are done in a way that they don't really care about compliance."

Scandals have not dented new investor enthusiasm either. After Mr Sussman's colleagues heard about what happened, they wanted to know how they could buy tokens too, he said.

Thanks to earlier investments in digital currencies, he said he recouped the stolen $20,000 within a week. "I'm not an ideologue," said Mr Sussman, "but regulation has the potential to make it more difficult for people like me to participate."